Why is the price of oil so low?

[TOM4CWB]

Why is the price of oil so low?

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Nov 25, 2006 (The Business - McClatchy-Tribune Business News via COMTEX) -- If a week is a long time in Westminster politics, four months is close to eternity for the global economy. When the oil price broke through the $78 mark to celebrate Bastille Day on 14 July, analysts were pretty united in saying it had no other way to go but up. They were spectacularly wrong: this week, after losing 30 percent of its value, oil is trading at close to its 17-month low, barely reacting to Lebanon's new crisis. Those who assured us that its price was about to go through the roof are now unashamedly predicting further declines.

So why did so many highly-paid analysts and fund mangers misread the oil market so badly, squandering so much of their investors' money? Their forecasts seemed plausible in July: Israel had just sent troops into Lebanon to tackle Hezbollah, a confrontation app-eared to be looming with Iran over its nuclear programme and the outlook for other volatile oil producer countries -- Nigeria, Venezuela, Iraq -- appeared grim.

It was not just the politics that were horrendous: producers and refineries on the American Gulf coast were bracing themselves for another devastating hurricane season; global economic growth remained buoyant, relentlessly demanding ever more oil; and BP was suffering from severe problems with its Alaskan pipeline.

All of the conditions for a simultaneous supply crunch and demand boom appeared to have been met; hedge funds piled into the market, anticipating the price would soon spike to $100 or higher.

It was not to be. A barrel of West Texas Intermediate closed at $58.02 on Tuesday, well below where some had feared (or hoped) it would be. North Sea Brent Crude was $59.60 a barrel in early trading on Wednesday.

The biggest change has been psychological: the markets, dazed by the mergers and acquisitions boom, record profits, huge bonuses and a global economic boom which shows no sign of ending, suddenly lost all interest in geopolitics, especially after it became clear that Israel's operations in Lebanon would not escalate.

Most traders and economists have decided that the best way to prepare for catastrophe in the Middle East is to stick their heads firmly in the sand and hope it will all go away. Seemingly conciliatory comments from despots, such as Iran's president Mahmoud Ahmadinejad, are welcomed as a good reason to sell oil; negative comments are ignored.

Following the Republican defeat in this month's US mid-term elections, there is a new consensus that talking with dictators will make them change their spots, even though all of the evidence (from dealing with Hitler in the 1930s onwards) suggests this to be nonsense.

In the real world, the catastrophe that would be a nuclear Iran is inching ever closer. With Israel understandably committed to preventing countries officially committed to its annihilation from getting the bomb, a catastrophic confrontation at some point appears increasingly hard to avoid, potentially jeopardizing traffic through the Straits of Hormuz, sending the price of oil soaring to new heights and inflicting massive pain on the world economy.

Parts of Iraq and maybe Afghanistan could once again serve as terror training grounds over the next few years, effectively putting much of the region -- and its oil wells -- on a collision course with the world.

Paradoxically, the bullish oil forecasts of a few months ago were structurally sound: they correctly implied that the price of oil ought to go up to price in a proper premium risk. But this missed the point of forecasting the behaviour of oil futures.

John Maynard Keynes' famous comparison of stock-picking with a beauty contest could just as well be applied to today's short-sighted oil market: "It is not a case of choosing those [faces] which, to the best of one's judgment, are really the prettiest, nor even those which average opinion genuinely thinks the prettiest", Keynes said. "We have reached the third degree where we devote our intelligences to anticipating what average opinion expects the average opinion to be. And there are some, I believe, who practise the fourth, fifth and higher degrees."

The complete disappearance of any meaningful geopolitical risk premium has knocked around $20 off the price of a barrel of oil. Only structural and speculative forces remain; and here too the picture looks very different. Supply is higher than expected and demand much weaker; refining capacity -- especially for diesel and plane fuel -- has increased; there were no major hurricanes in the Gulf this year; the weather has been warmer; and BP sorted out its problems faster than expected. Many of the hedge funds that pumped their billions into commodities have now moved on to equities, further depressing the price of crude.

Most striking has been the weak demand for oil, despite buoyant global economic growth estimated at 5 percent by the International Monetary Fund (IMF) in 2006, despite the slowdown in America.

The International Energy Agency's October report suggests that demand in the rich countries of the OECD for crude oil is likely to decrease by 0.2 percent this year. Remarkably, this comes despite accelerating growth in those countries, from 2.5 percent last year to around 3 percent this year, partly thanks to stronger than expected growth in Europe.

If past relationships between economic growth and the world's thirst for oil were still valid, Morgan Stanley calculates that global demand should have increased by 2.2m bpd (barrels per day) this year, against an IEA forecast of just 0.9m bpd. Western economies and consumers are reacting to a price of oil now 190 percent in real terms above the 1986-1999 average.

"Substitution among sources of energy and conservation are rational economic reactions to higher relative prices", says Eric Chaney, chief economist for Europe at Morgan Stanley.

Total demand for oil in the third quarter was 83.9m bpd, up from 83.3m bpd a year ago. Total supply this quarter was 85.6m bpd, up significantly from 84.3m bpd in 2005 and 79.8m bpd in 2003. Spare capacity and reserves have therefore risen markedly.

Opec's contribution to supply is 34.7m bpd. Total demand next year is now expected to be 85.9m bpd, a forecast which is probably too high given the rich economies' newly-discovered restraint in oil consumption. But even if these forecasts for demand growth materialise, total non-Opec supply in 2007 is set to grow to 52.7m bpd from 50.9m bpd in the third quarter of this year, slightly loosening the world's dependence on the cartel.

Opec's decision last month to reduce output by 1.2m bpd from 1 November is not worth the paper it's written on. Tanker traffic from Opec ports suggests it has managed to cut just 300,000 barrels of this. Other data suggests production actually inc-reased in November, as greedy cartel members reneged on their commitment.

For the time being, the oil price looks likely to remain low; many even believe that supply, including that from Canada's oil sands, will remain plentiful for a long time. This may be true; but given that the market is adding absolutely no premium for risk into the price of oil -- an absurd assumption -- the first geopolitical disruption big enough even for complacent traders to notice will send the price back up through the stratosphere. That doesn't include Lebanon.

A focus on supply fundamentals is all well and good but won't help if Iranian or Iraqi oil fields suddenly go up in flames. Companies and consumers should enjoy cheap fuel while it lasts.

By Allister Heath And Richard Orange

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[TOM4CWB]

Amid questions about crimped supply, industry denies manipulation to keep prices high

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BAKERSFIELD, Calif., Nov 25, 2006 (The Canadian Press via COMTEX) -- You'd think it was Texas. Dusty roads course the scrubland toward oil tanks and warehouses. Beefy men talk oil over burritos at lunch. Like grazing herds, oil wells dip nonstop amid the tumbleweed - or even into the asphalt of a parking lot.

That's why the rumor sounded so wrong here in California's lower San Joaquin Valley, where petroleum has gushed up more riches than the whole gold rush. Why would Shell Oil Co. simply close its Bakersfield refinery? Why scrap a profit maker?

The rumor seemed to make no sense. Yet it was true.

The company says it could make more money on other projects. It denies it intended to squeeze the market, as its critics would claim, to drive up gasoline profits at its other refineries in the region.

Whatever the truth in Bakersfield, an Associated Press analysis suggests that big oil companies have been crimping supplies in subtler ways across the country for years. And tighter supplies tend to drive up prices.

The analysis, based on data from the U.S. Energy Information Administration, indicates that the industry slacked off supplying oil and gasoline during the prolonged price boom between early 1999 and last summer, when prices began to fall.

The industry counters that it's been working hard to meet untiring demand. It faults output quotas set by Mideast oil powers, global competition for oil from booming economies like China's, and domestic challenges like depleting wells, clean-air rules, and hurricanes. They do make things harder.

Yet the AP analysis found evidence of at least an underwhelming industry performance in supplying the domestic market, when profits should have made investment capital plentiful:

-During the 1999-2006 price boom, the industry drilled an average of 7 per cent fewer new wells monthly than in the seven preceding years of low, stable prices.

-The national supply of unrefined oil, including imports, grew an average of only 6 per cent during the high-priced years, down from 14 per cent during the previous span.

-The gasoline supply expanded by only 10 per cent from 1999 to 2006, down from 15 per cent in the earlier period.

The findings support a conclusion already reached by many motorists. Fifty-five per cent of Americans believe gas prices are high because oil companies manipulate them, a Pew Research Center poll found in October.

Even in Bakersfield, which lives off oil, many suspect that the industry goes easy on supply for its own reasons. "They ain't trying: that's more money for them," snorted JaRayle Madden, a construction worker filling up his little sedan recently at a local Shell station.

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This fast-growing city of 300,000 shuddered in November 2003, when Shell confirmed it would soon close its local refinery. Plant workers, consumer activists and public officials rose up in resistance, firing off letters and demanding meetings.

The 70-year-old refinery only produced 2 per cent of California's gasoline and 6 per cent of its diesel fuel. Yet opponents feared its demise would push up prices in the tight markets all along the West Coast.

In these circumstances, surely the plant was worth something to someone, if not to Shell. After losing $57 million mostly in the aftermath of the Sept. 11 terrorist attacks, the refinery was making money again, Shell acknowledged.

Though set back temporarily by the attacks, the oil business has profited handsomely since then. For example, the biggest six refiners - Shell is only No. 12 nationally but powerful in California - rang up $400 billion in profits since 2001, according to the consumer group Public Citizen and corporate reports. Even compliance with complex clean-air rules hasn't spoiled business.

The industry also protected profits by not building any new refineries, instead expanding existing ones when it could.

Shell portrayed its Bakersfield refinery as old and unfit. One executive said there was "simply no longer an adequate supply of crude oil" nearby.

Drillers across the country complain of maturing wells that are slowly running low. Gas or liquid is sometimes injected into reservoirs at higher cost to keep up the flow.

"The industry is working very hard," says Joe Sparano, who heads the Western States Petroleum Association representing Shell and other drillers, refiners and marketers.

However, oil reserves are expected to last for decades around Bakersfield and elsewhere, according to industry and government estimates. Fresh national reserves are found each year. To make up for older wells, oil companies regularly drill new ones - about 9,800 last year. Underground discoveries and technological strides have kept domestic reserves at the same level as in 1999.

With demand growing, though, the United States has imported an expanding share of its oil from abroad - and quotas kept by Mideast nations do lift its price.

It's also true there's a new big buyer of oil: China, with its flourishing economy. Yet even China hasn't outstripped the world's capacity to deliver more oil, at least so far. Since 1999, world supplies grew four times more than China's imports, federal data show.

Imports were impractical at inland Bakersfield, Shell explained. Lynn Laverty Elsenhans, the head of Shell Oil Products US, said the refinery here just wasn't viable anymore.

"For this reason, we have not expended time or resources in an attempt to find a buyer and do not intend to do so," Elsenhans wrote to U.S. Sen. Barbara Boxer, D-Calif.

Shell's blunt tone began to trouble opponents of the plan. Union officer Ed Huhn, a former refinery worker who was trying to keep the place open, began to wonder if it was folly. "They were trying to discourage anybody from buying it," he says.

Skeptics like U.S. Sen. Ron Wyden, D-Ore., got more vocal. They began to suspect that Shell wanted to shut the refinery to sell pricier gas from its bigger refineries elsewhere in the region. By taking a hit at Bakersfield, maybe Shell could come out ahead.

"They were trying to squeeze the market in every possible way," Wyden insists.

Shell spokesman Stan Mays denies that. He says it's "impossible to speculate" on whether Shell would have profited from closing the plant.

But he indirectly acknowledges that Shell didn't intend to make the refinery attractive for a competitor: "Who's going to want to buy it? We're not going to give crude supply with it."

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It turns out that the industry exerts quite a bit of control over supply.

For one thing, it decides to invest in new wells and refining equipment - or not to. Though reserves have kept pretty steady, the oil industry taps those resources to varying degrees from year to year. The long price run-up first took off as the number of new wells abruptly dropped by a total of 59 per cent in 1998-99, federal records show.

One consumer advocate, Mark Cooper, refers to industry-induced supply bottlenecks as "strategic underinvestment." He views references to "discipline" in annual corporate reports as a code word for going easy on supplies.

"Anytime someone talks about 'discipline,' this suggests to me that they have market power. They're choosing what investments to make," says Cooper, research director for Consumer Federation of America.

There's evidence he may be right. A 2001 study by the Federal Trade Commission reported that some firms were deciding to "maximize their profits" by crimping supply during a Midwestern gasoline price spike. One executive told regulators "he would rather sell less gasoline and earn a higher margin on each gallon sold."

This year, the FTC reported that some oil companies were storing oil, instead of selling it right away, to await higher prices anticipated in the future.

The industry has shelved an average of 21 per cent more unrefined oil from the start of 2004 through last June, the AP analysis indicates. Last spring, stocks of shelved crude reached their highest level in eight years, despite the fabulous riches at hand in high prices then.

Such a strategy could conceivably extend to drilling too. "If you think prices 10 years from now are going to be $100 a barrel, you might not be that enthused about producing as much as you can now," suggests energy economist Allan Pulsipher at Louisiana State University.

However upsetting to drivers, such tactics are usually viewed as legal. "A decision to limit supply does not violate the antitrust laws, absent some agreement among firms," regulators wrote in one FTC report.

Also, individual companies are freer to bottle up supplies without fear of losing business to competition, because fewer companies now control a production choke point: refining. Thanks to mergers, the top 10 companies now control three-quarters of national refining capacity, up from half in the early 1990s.

"A handful of very large companies realize it's in their mutual interest to keep prices as high as possible," says Tyson Slocum, an energy expert at the consumer group Public Citizen, founded by Ralph Nader. "I don't think they're sitting around a table smoking cigars and price fixing, but I think there are sophisticated ways to manipulate the market."

In Bakersfield, government regulators eventually began to nose around, wondering if Shell hoped to game the market. But the company finally hired an investment banker to scout buyers. In January 2005, it announced a sale to truck-stop operator Flying J, of Ogden, Utah, which also runs a small refining business. The price was kept secret. Shell did nothing wrong, federal regulators later decided.

Since the sale, drillers and refiners have been making profits as never before.

The back-to-back hurricanes along the Gulf Coast in 2005 crippled about a third of the country's oil-output capacity and a fifth of its refining - but only temporarily. For all its talk of supply challenges, the industry quickly arranged for more imports and avoided outright national shortages. But prices jerked upward.

In Bakersfield, Flying J's 350 refinery workers now process 2.7 million gallons of oil a day - as much as Shell did - in the churning nest of boilers, piping and stacks venting six stories above the scrubland.

"It's still a good refinery, good people, a lot of money to be made in the long term," says Andy Wheeler, the engineering manager transplanted from Louisiana. "There's still plenty of oil locally to produce."

The new owner won't discuss current profits but acknowledges making money. With limited oil from Shell, Flying J has kept its boilers busy with crude from other wells, also right here in the valley.

In fact, the refinery is so full of promise that Flying J has decided to spend several hundred million dollars to nearly double its gasoline output. It hopes to make about $85 million more a year in profit.

"Shell, in the last few years of operation, didn't invest any money into the place," says Wheeler, tooling past its giant storage tanks in his shiny SUV.

But the refinery's new bosses, says manager Gene Cotten, are "comfortable enough with the long-term crude supply to make that investment."

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[cottonpicken]

I see 100$ a barrel by the first day of spring.Iran is about to go up in smoke.But more important Saudi arabia could burn.